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Sunday, November 16, 2014

Below the fold is a recent Twitter discussion I had with David Andolfatto and Noah Smith on Neo-Fisherism. The big takeaway from this conversation is that we all view the expected path of the consolidated government balance sheet as being a key determinant for current aggregate demand growth. This
understanding has been implicit in Market Monetarist's calls for level targeting and
explicit in our calls for a permanent expansion of the monetary base in a depressed economy. The fact that we have not seen rapid aggregate demand growth is strong evidence that the Fed's QE programs are not expected to permanently alter the consolidated government balance sheet.

The key difference between us that I see is that Neo-Fisherites question our
assumption that fiscal policy would not offset a central bank attempting to
permanently expand the monetary base. My reply is that if in a depressed economy monetary policy did go to some kind of level targeting (or a higher inflation target for folks like Paul Krugman) it would be a big regime change that would require political consensus and have Treasury's backing. Nick Rowe goes further and argues that even in a normal economy fiscal policy typically responds in a supportive role to monetary policy, not the other way around:

I am of the view that the Bank of Canada targets 2% inflation (or NGDP
or whatever), and it adjusts the nominal interest rate (or base money or
whatever) to hit that target, and its actions affect its profits, and
those profits affect the government's spending and taxation decisions.
In the long run, the government adjusts its budget to be consistent with
the Bank of Canada's actions. Not vice versa. We saw that adjustment in
1995.

The point is that absent a troubled-state environment where fiscal policy does dominate and shape monetary policy actions (e.g. Zimbabwe 2008-2009) it is reasonable to assume the actions of fiscal policy will support and be consistent the objectives of monetary policy.

Along these lines, it is interesting to look back at my NGDP growth path target proposal that would have the U.S.Treasury Department take over and do helicopter drops when the Fed failed to hit some NGDP level target. My original motivation for this proposal was to insure against central bank incompetence in stabilizing aggregate demand. (The threat of the Treasury temporarily taking over monetary policy would also provide a strong incentives for Fed officials to do their job.) In doing so, however, this proposal would also serve to manage the expected path of the consolidated government balance sheet in a manner that would stabilize aggregate nominal expenditures. The proposal, then, is very Neo-Fisherian in spirit. So in some ways we are not all that different.